La Laguna Ranch Co. v. Dodge

114 P.2d 351, 18 Cal. 2d 132, 135 A.L.R. 546, 1941 Cal. LEXIS 344

• Court: California Supreme Court
• Decided: June 20, 1941
• Docket: L. A. 16911
• Status: Published

Opinions

GIBSON, C. J.

The plaintiff commenced this action in the Superior Court of Santa Barbara County to quiet title to certain real property situated in that county. Defendants Hugo D. Newhouse and Arthur A. Newhouse appeal from a judgment in favor of the plaintiff. The facts are for the most part undisputed. Prior to October 18, 1935, plaintiff was the owner in fee of the property in question. On or about that date an oil and gas lease was entered into between plaintiff, as the lessor, and C. C. Boatright and A. M. Meacham, as lessees. The lease was to continue for a period of five years and for so long thereafter as drilling operations were being conducted or oil and gas were being produced in paying quantities. The lessor was to receive a sum equal to one-eighth of the market price of the oij and gas produced as a royalty, or if no oil was sold, the royalty was to be paid in kind. After the expiration of one year a rental of a stipulated price per acre per year was provided in lieu of continuous drilling and development by the lessees. The lessees were required to commence the drilling of a well within sixty days of the date of the lease and the first well wa.s to be completed within one year. Breach of any of the terms of the lease and the failure to remedy such breach within thirty days after written notice from the lessor gave the lessor the option to forfeit all rights of the lessees.

In November, 1935, the lessees entered into a written agreement by which they assigned to the defendants herein a fractional interest, therein termed an “overriding royalty”, in all petroleum, oil, or gas thereafter produced under the terms of the lease. Defendants’ claim of an interest in the real property here involved is founded upon this assignment of a fractional interest in the oil to be produced. On or about May 19, 1936, after the president of the plaintiff company had indicated that it was about to declare a forfeiture of the lessees’ interest for failure to commence the drilling of a well within the sixty-day period, quitclaim deeds were executed from the lessees and their successors in interest to the lessor, La Laguna Ranch Co. Each deed contained a clause indicating that the lessees had been unable to comply with the terms of the lease. The superior court found that the lessees had forfeited all their right and interest in the land, that the claim of the defendants, Hugo D. Newhouse and Arthur A. Newhouse, was without merit and that neither of the defendants had any right, title or estate in the real property in question. On the basis of these findings a decree was rendered quieting title in favor of the plaintiff, and from this judgment defendants have appealed.

The question thus presented for our determination may be stated as follows: Does the interest of the holder of a fractional share in the production of oil, which is created out of the estate of the operating lessee, survive after the lessee’s voluntary surrender of the leasehold by a quitclaim deed?

The term “overriding royalty” is applied generally in the industry to such fractional interests in the production of oil and gas as are created from the lessee’s estate. This is true whether the overriding royalty is created by reservation when the original lessee transfers his interest by a sub-lease or whether it is created by grant when the original lessee conveys a fractional share to a third person, as in the instant case. Similarly, the term “royalty” is generally applied to the fractional interests in the production which are created by the owner of the land either by reservation when an oil and gas lease is entered into or by direct grant to a third person. The legal attributes of such royalty interests have been considered in recent opinions of this court. The case of Callahan v. Martin, 3 Cal. (2d) 110 [43 Pac. (2d) 788, 101 A. L. R. 871], examined the nature of the various interests created under oil and gas leases in California and must be regarded as the starting point in considering the problems here presented. Thus, it is now established that the owner of land does not have an absolute title to the oil and gas in place as corporeal real property, but rather has the “exclusive right” to drill for oil and gas upon his premises. (Callahan v. Martin, supra, p. 117.) Where the owner of land enters into an oil and gas lease which grants to an operating lessee the privilege of entering upon the land for the purpose of producing oil and gas,' the interest thus created in the lessee is a profit a prendre, that is an incorporeal hereditament or interest in real property. (Callahan v. Martin, supra, pp. 118-122.) Where, after entering into such an oil and gas lease, the lessor assigns to third persons fractional interests in the royalties which he has reserved to himself, the holder of such a fractional interest acquires an interest in real property, an incorporeal hereditament analogous to the right to receive future rents of real property. (Callahan v. Martin, supra, p. 124; Dabney-Johnston Oil Corp. v. Walden, 4 Cal. (2d) 637, 651 [52 ].) The court did not determine the nature of the fractional interests in production which are created out of the lessee’s estate. It was held, however, that the prior cases dealing with such 11 overriding royalty” interests on the theory that the assignments transferred personal property of which the lessee had potential possession could no longer be considered controlling in view of the abolishment of the “potential possession” doctrine in California. (Callahan v. Martin, supra, p. 128; Schiffman v. Richfield Oil Co., 8 Cal. (2d) 211, 225, 226 [64 Pac. (2d) 1081].) It is clear, therefore, that the line of California eases dealing with oil leases and overriding royalty interests under the potential possession doctrine can no longer be considered controlling. (See, for example, Western Oil etc. Co. v. Venago Oil Corp., 218 Cal. 733 [24 Pac. (2d) 971, 88 A. L. R. 1271]; Brookshire Oil Co. v. Casmalia etc. Co., 156 Cal. 211 [103 Pac. 927]; Smith v. Drake, 134 Cal. App. 700 [26 Pac. (2d) 313]; Merrill v. California Pet. Corp., 105 Cal. App. 737 [288 Pac. 721]; Black v. Solano Co., 114 Cal. App. 170 [299 Pac. 843]; Jones v. Pier, 124 Cal. App. 444 [12 Pac. (2d) 646].)

The question whether the overriding royalty interest of the defendants herein survived despite the quitclaim deeds by which the operating lessees surrendered their interest to the lessor has not been answered by the decisions of this court. A similar problem was presented, however, in the case of Payne v. Callahan, 37 Cal. App. (2d) 503 [99 Pac. (2d) 1050]. The court in that case attempted to apply the principles laid down in Callahan v. Martin, supra, to the facts there involved. In Callahan v. Martin, after recognizing that the interest of an operating lessee under an oil and gas lease was in fact a profit á prendre, it was determined that the lessor had attempted to convey a fractional interest which was to endure, not merely for the period of the existing lease, but after a termination of the lease as well. Thus, the lessor was held to have created a fractional interest not only in his own reserved royalty interest throughout the pending lease, but to have granted in addition a fractional interest in the reversion. (See Schiffman v. Richfield Oil Co., supra, p. 223; Dabney-Johnston Oil Corp. v. Walden, supra, p. 651.) The court held that the assignee of such an interest became, in effect, a tenant in common of the landowner’s exclusive right to drill for oil and gas after the existing lease had terminated. (Callahan v. Martin, supra, p. 125.) The holder of such an interest, after the termination of the existing lease, was held to possess a right of entry to go on the land and drill for the oil, or, in other words, to have been granted a profit á prendre similar to the interest held by the ordinary operating lessee under an oil and gas lease. In Payne v. Callahan, supra, the District Court of Appeal reasoned that if the lessor’s assignment of a portion of his royalty interest had created in the assignee a profit á prendre in Callahan v. Martin, then the assignment of an overriding royalty by an operating lessee should be held to create a profit á prendre in his assignee. (Payne v. Callahan, supra, p. 516.) Similarly, the court said that if- the lessor’s assignment in Callahan v. Martin had made the assignee a tenant in common of the profit á prendre, the operating lessee’s assignment should be held to have made the assignee a tenant in common in the lessee’s profit á prendre. (Payne v. Callahan, supra, p. 517.) Relying upon the decision in Payne v. Callahan, defendants urge that the overriding royalty granted to them by the operating lessees herein made them tenants in common in the lessees’ profit á prendre. Therefore, it is contended, as tenants in common of an interest in real property, defendants hold an interest which survives despite the asserted co-tenants ’ attempt to quitclaim the entire interest back to the landowner-lessor.

The position urged by defendants in this appeal is one which is supported by the ease of Payne v. Callahan, supra. We are convinced, however, that the position there taken by the District Court of Appeal is based upon a misconception of this court’s holding in Callahan v. Martin, supra. In that case we recognized that the interest created in any case depended upon the intention of the parties involved. Under the facts there presented, we found that the landowner-lessor had intended to grant a fractional interest in the reversionary interest as well as a fractional share of his reserved royalty during the existence of the pending lease. (See Schiffman v. Richfield Oil Co., supra, p. 223; Dabney-Johnston Oil Corp. v. Walden, supra, p. 651.) But it is clear that the landowner-lessor does not intend in every case to make his assignee a co-tenant in his exclusive right to drill for gas and oil. He may grant merely a fractional interest in his reserved royalty, an interest which is not intended to endure beyond the limits of an existing lease. Such a limited interest creates in the holder an interest in real property, an incorporeal hereditament (Callahan v. Martin, supra, pp. 123, 124; Dabney-Johnston Oil Corp. v. Walden, supra, p. 651), but it does not contemplate the grant of a profit á prendre. The assignee does not intend to attempt operation himself and is given no right of entry for such purpose. Those rights are held by the operating lessee, and the holders of royalty interests contemplate nothing more than the receipt of their share of the oil and gas production.

Similarly, while the operating lessee may assign an interest in his profit á prendre which is intended to make the assignee a tenant in common of his entire leasehold estate, he may, on the other hand, intend to retain in himself the operating rights contained in the profit a prendre, conveying to the assignee merely a fractional share of the oil and gas produced in the form of an overriding royalty. (See Schiffman v. Richfield Oil Co., supra, pp. 224, 225.) Thus, in so far as Payne v. Callahan, supra, holds that the fractional interests created either by the lessor or the operating lessee constitute a tenancy in common in a profit á prendre as a matter of law, it is expressly disapproved. In any case, the intention of the parties is controlling, and in the absence of a clear indication that such was the intent, the court will not construe royalty interests created for the duration of a specific oil and gas lease as granting the right to enter upon the land in question for the purpose of carrying on oil production or as creating a tenancy in common in the profit d prendre for that purpose. The instrument creating the overriding royalty interests of the defendants herein evidences no intent that defendants were to become tenants in common of the lessees’ profit d prendre. The instrument recites the fact that the operating lessees were required to commence the drilling of an oil well and indicates that the defendants’ only function was that of furnishing capital for this purpose. All actual operation was left in the hands of the lessees and it is clear that the parties contemplated no right of entry in the defendants for the purpose of drilling for oil and gas. It follows that no tenancy in common was created in the profit d prendre of the operating lessees.

This court in Schiffman v. Richfield Oil Co., supra, p. 225, did not define the nature of the interest created by the assignment of such overriding royalty interests as are present here. It was assumed, however, that no interest in the operating lessee’s profit a prendre was intended to be conveyed. In Callahan v. Martin, supra, pp. 123,124, similar rights to share in the production of oil and gas were held to be interests in real property when created by the lessor. That holding was based upon the analogy drawn between the right to receive future rents from real property and the right to receive oil royalties reserved by the lessor in an oil and gas lease. (Callahan v. Martin, supra, p. 123; Dabney-Johnston Oil Corp. v. Walden, supra, p. 651; Schiffman v. Richfield Oil Co., supra, p. 223; see 101 A. L. R. 884, 886.) A similar conclusion may be reached where the lessee, not intending to operate the oil wells himself, makes a sub-lease and reserves an overriding royalty for himself. Again the analogy between rents and the reservation of oil royalties justifies the classification of such oil royalties as incorporeal interests in real property. Where, however, the landowner grants an oil “royalty” without having previously leased the land to another (see Denio v. Brennecke, 6 Cal. App. (2d) 678 [45 Pac. (2d) 229]), or where the operating lessee grants an “overriding royalty”, it is clear that the interest thus created cannot be fitted into the category of' rent. This court has recently referred to the fact that the traditional categories of real property interests crystallized long before interests such as these found their way into the courts. (Callahan v. Martin, supra, p. 115.) The law relating to such oil rights has been said to be in a formative stage and the interests thus created have been considered sui generis. (Dabney-Johnston Oil Corp. v. Walden, supra, pp. 650, 651; Schiffman v. Richfield Oil Co., supra, p. 226.) Thus, although only a portion of the oil royalties here considered can actually be compared to rent in the traditional sense, the purpose and scope of all such royalty interests are so similar that all should be considered equally to be incorporeal interests in real property, subject to the same requirements and protected by the same safeguards. (See Spath v. Seager, 39 Cal. App. (2d) 10, 14 [102 Pac. (2d) 350]; Fairbairn v. Eaton, 6 Cal. App. (2d) 264, 268 [43 Pac. (2d) 1113]; Denio v. Brennecke, supra; 3 Summers, Oil & Gas, sec. 556, p. 332 et seq.; 26 Cal. L. Rev. 480-486; 13 So. Cal. L. Rev. 393, 410-422; 11 So. Cal. L. Rev. 319, 326; 25 Cal. L. Rev. 220.)

Defendants’ overriding royalties were, therefore, interests in real property. (Cf. Phillips Petroleum Co. v. Taylor, 116 Fed. (2d) 994, 995; Rowan v. Harburney Oil Co., 91 Fed. (2d) 122, 124; King v. Gants, 77 Okl. 105 [186 Pac. 960]; Tennant v. Dunn, 130 Tex. 285 [110 S. W. (2d) 53].) The interests thus created were not unlimited but were determinable interests limited to the duration of the existing lease. Termination of the oil and gas lease would result in the termination of the interests created under it. (See Phillips v. Bruce, 41 Cal. App. (2d) 404 [106 Pac. (2d) 922].) Defendants do not contest the general principle involved, but it is contended that the lease in the present case was not lawfully terminated since the forfeiture provisions in the lease were not complied with. Ordinarily, however, such oil and gas leases contain clauses permitting the lessee to cease operations and to surrender the lease if he no longer considers it possible to continue operations profitably. The lease here involved provided: “5. Lessee may at any time . . . quitclaim the said premises, or any part thereof, to the Lessor . . . Upon the quitclaiming of any part of the land to the Lessor, his successors or assigns, all rights and obligations of the parties . . . shall cease and determine . . . ” It follows that the surrender of the leasehold interest by the lessees constituted a termination of the profit a prendre and the leasehold. Defendants, as holders of the overriding royalty interests, had knowledge of the terms of the original lease incorporated by reference into the instrument creating the overriding royalties. Defendants contemplated the purchase of a speculative interest in real property which they intended should be determinable by the lessees. Failure to meet the conditions of the lease might result in forfeiture. Continued drilling might prove that no oil could be produced from the land in question. Any of these contingencies would result in the termination of defendants’ interest. We do not see how the surrender of the leasehold by the lessees imposes any uncontemplated risk upon the holder of the overriding royalty. No contention was made that the surrender of the lease was a fraudulent act or that others were unjustly enriched at the expense of the overriding royalty holders. If fraud or inequity were present, the courts would stand ready to provide redress for the injured party. In the present case, however, the surrender of the leasehold by quitclaim deeds operated to terminate the interests of the defendants, as well as the interest of the lessees, in plaintiff’s land.

The judgment is affirmed.

Shenk, J., Curtis, J., Traynor, J., and Edmonds, J., concurred.